Beginner's guide to bond investment

Winning through stability – Bond investment and volatile markets

Bonds are debt instruments issued by governments, corporations or other issuers to bondholders. Bondholders are effectively lending money to the bond issuer in return for the regular interest payment over the life of the bond and repayment of principal at maturity.

Investing in bonds can grow your wealth and diversify your overall portfolio. Given the unpredictability and volatility of international markets, it is important to plan ahead and prepare for the unexpected risks.

Bonds are an essential component of a well-balanced portfolio throughout every stage of your life.

Inflation-linked retail bond (iBond), Retail Green Bonds or Silver Bond Series issued by the government might be familiar to you but there are actually many types of bonds and more choices in the market. Are bonds only suitable for professional investors? Let’s debunk a few of the most common myths and learn more about bonds!

4 myths you should know about bond investment

Lower returns mean bond investment is not worth it?

Bonds may offer lower returns than stocks, but they exhibit lower volatility and provide a steady source of income (Bondholder is able to get back the principal if held to maturity assuming the bond issuer does not default due to financial difficulties).

In general, high investment grade bonds can provide a steady source of income in the form of regular coupon payments and predictable repayment of principal at maturity, making them good fits for more conservative investors whose main goal is to generate passive income.

Bond vs bond funds: What are the differences between bonds and bond funds?

Bonds could provide interest payments over a specific term plus repayment of principal at maturity whereas bond funds are collections of bonds that are professionally managed for total return and a specific objective. Investors will be charged for management fee, subscription fee, etc. The 2 may seem similar, but here are some key differences:

  Individual Bonds
Bond Funds
Principal Repayment of principal[1] No guarantee of principal repayment
Payment Usually annually or semi-annually, in terms of coupon payment Payment schedule is not fixed; it depends on the fund performance and strategy
Fees and charges Subject to individual bank's fee policy, but in general, there is no management fees and trading fees

Including, but not limited to, service charges, management and trading fees

The minimum subscription amount must be high?

Minimum subscription amount depends on the issuer. While some bonds have a minimum denomination of USD100K or USD200K, the minimum subscription amount of some retail bonds e.g. ibonds that are issued by the government is HKD10K.

Bond investment is suitable for professional investors only but not bonds beginners?

While professional investors can access a wider selection of wealth products and dedicated advisory services from a team of wealth management experts provided by the Hang Seng Bank, bond investment is in fact suitable for any types or levels of investors, especially investors with a goal to achieve a steady source of passive income.

Bond 101: Key concepts and terminologies

Coupon vs Yield-to-maturity (YTM)

Coupon rate refers to the annual interest rate paid on bond’s face value, while yield-to-maturity (YTM) is the total rate of return that an investor received from holding the bond until maturity.

Unrated bonds are not necessarily riskier

Bonds with a credit rating of BBB- (on Standard & Poor's and Fitch scales) or Baa3 (on Moody's) or above are classified as investment grade and they are considered to have lower default risk.

Despite risk rating provides a useful measure of risk assessment i.e. evaluating the probability of a bond defaulting, the absence of a bond rating does not necessarily imply that the bond is risker than that with a credit rating. An unrated bond simply means that a credit agency has not attached a bond rating to it.

In fact it is quite common for governments and some multinational companies to issue unrated bonds due to a number of reasons i.e. the costs incurred and the issue size of a bond, some issuers would choose not to have their bonds rated.

Interest rates drive bond prices up and down

Bond prices and interest rates are inversely related. Bond prices generally drops when interest rates rise, and vice versa. Moreover, the higher the credit rating of the bond, the lower the yield-to-maturity (YTM). Bonds with long maturities are more sensitive to a change in market interest rates. Conversely, bonds with shorter maturity dates will be less volatile in a changing rate environment.

Bond prices may drop affected by rate-hike expectation

When the market interest rate is expected to rise, bond prices might fall. In general, short-term bonds are less sensitive to interest rates changes.

Bond investment strategy: Factors to be considered for bond subscription or redemption

You might consider changing your bond investment strategies during times of market volatility. Do you have to hold a bond until it matures? While holding it to maturity might provide more predictable return, you may get a different amount than its par value by selling it before it matures. For example, if interest rates have fallen since the bond was purchased, you may be able to gain by selling it a premium above par and vice versa.

Bond Dirty Price vs Bond Clean Price

Dirty Price = Clean Price + Accrued Interest

Accrued Interest refers to the amount of interest that has accumulated since the principal investment or since the last interest payment date.

For example:

Dirty Price = HKD1,500 + HKD6.37 = HKD1,506.37

Therefore, the dirty price of a bond sold on January 1 would be HKD1,506.37.

Know more about types of bonds and their features

Zero-coupon bond – without interest payment

It makes no periodic interest payment but instead it usually offers discounts on its face value. The earnings accumulate until maturity when they are redeemed at face value on a specific maturity date.

Perpetual bond – without maturity date

The issuer is not obligated to repay principal to the investors; but the issuer has an obligation to provide interest payments forever until the issuer recalls the bond.

Callable bond – redeemable at a predetermined price on or after specific date by the issuer before maturity

Usually pays a higher interest rate to compensate for the early call. It also comes with call protection when there is a specific period during which the issuer cannot recall the bond.

Convertible bond

Bonds that can be converted into a predetermined amount of the company’s equity at certain times during its life, usually at the discretion of the bondholder.

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Capital Protected Investment (CPI) Deposit

  • Invest online with just HKD5,000
  • 100% capital protection at maturity
  • Invest for as short as 2 months with no handling fee
  • A variety of underlying currency pairs
Investment involves risks. Prices of foreign exchange and the relevant investment products may go up or down.

Equity Linked Investments

  • Potential return based on performance of linked stocks
  • Flexible tenor from 1 month to 3 year
  • Customised strike price
Investment involves risk.

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experience is just a few steps away[3]

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Footnote

Other Point(s) to note

Investors should note that all investments involve risks (including the possibility of loss of the capital invested). Investors should read carefully and understand the relevant offering documents before making any investment decision.

Remark(s)

  1. Except event of default
  2. You can open a bank account online with your mobile phone only if you do not hold any of the following Hang Seng Bank accounts, including but not limited to:
    • Savings / Current Account (including passbook and statement savings account)
    • Integrated Account
    • Credit Card Account
    • Business Account
    • Joint-named Account
    • Mortgage Plan
    • Safe Deposit Box Services
    The service is also only available if you fulfil all of the below criteria:
    • Aged over 18 and under 65
    • A permanent Hong Kong resident
    • Not a US citizen or tax resident
    • Residing in Hong Kong (with current residential and correspondence address(es) in Hong Kong)
    • Currently located in Hong Kong
  3. Integrated account is referring to the following accounts:
    • Prestige Banking
    • Preferred Banking
    • Green Banking
    • Integrated Account
    • M.I. Kid Asset Builder Account